Capital gain treatment for self-created musical work

Music composer tax related capital gain treatment

IRS Temp reg describes how and when to elect capital gain treatment for self-created musical works

T.D. 9379, 02/07/2008, Reg. § 1.1221-3T; Preamble to Prop Reg 02/07/2008, Prop Reg § 1.1221-3

IRS has issued a temporary reg on the time and manner for making an election under Code Sec. 1221(b)(3) to treat gain or loss from the sale or exchange of certain musical compositions or copyrights in musical works as gain or loss from the sale or exchange of a capital asset. The text of the temporary reg also serves as the text of the proposed reg.

Background. The Tax Increase Prevention and Reconciliation Act of 2005 provided an exception to the rule that copyrights or literary, musical or artistic compositions, letters or memorandums or similar property are not capital assets or Code Sec. 1231 capital gain-ordinary loss assets. For sales or exchanges in tax years beginning after May 17, 2006, a taxpayer may elect to treat a sale or exchange of musical compositions or copyrights in musical works created by the taxpayer’s personal efforts–or having a basis determined by reference to the basis in the hands of a taxpayer whose personal efforts created them–as the sale or exchange of a capital asset. ( Code Sec. 1221(b)(3) ) Although this exception was originally a temporary measure, it was later made permanent by the Tax Relief and Health Care Act of 2006.

Observation: As a result, a composer who sells his copyrighted composition in a sale and makes this election will pay tax at the lower rates that apply to capital gain.

Making the election. The temporary reg, which is retroactively applicable to sales and exchanges in tax years beginning after May 17, 2006, provides that a taxpayer makes the election by treating the sale or exchange as the sale or exchange of a capital asset, in accordance with the applicable form and its instructions. The taxpayer must make a separate election for each musical composition (or copyright in a musical work) sold or exchanged during the tax year. The election is made on Schedule D, Capital Gains and Losses, of the appropriate tax form (e.g., Form 1040, U.S. Individual Income Tax Return; Form 1065, U.S. Return of Partnership Income; Form 1120, U.S. Corporation Income Tax Return). The taxpayer must make the election on or before the due date (including extensions) of his return for the tax year of the sale or exchange. (Reg. § 1.1221-3T(b))

Revoking the election. An election to elect capital gains treatment is revocable with IRS’s consent. To request that consent, a taxpayer must submit a request for a letter ruling under the appropriate revenue procedure (e.g., Rev Proc 2007-1, 2007-1 CB 1 (as updated annually). Alternatively, an automatic 6 month extension from the due date of a taxpayer’s return (excluding extensions) will be granted to revoke an election if the taxpayer timely filed his return and, within the 6-month extension period, files an amended return that treats the sale or exchange as the sale or exchange of property that isn’t a capital asset. (Reg. § 1.1221-3T(c))

The election of capital gain treatment for self-created musical work.

Mike Habib, EA
MyIRSTaxRelief.com